he yen, which is the third most popular traded currency in the FX market, has shed almost 2% of its value in the past 24 hours, weighed down by fears over the economic impact of the coronavirus outbreak. The Japanese currency was one of the main beneficiaries following the virus’ outbreak as investors piled into the safe-haven currency. Investors are, however, now turning their attention to the potential long-term economic impact of the virus which, according to a Bloomberg report released yesterday, is expected to be among the most severely felt in Japan.

The Japanese economy has already suffered in the past few months. The economy contracted by 1.6% quarter-on-quarter in the final three months of last year (an annualised pace of 6.3%), in large part due to the effect of October’s sales tax hike. With Japan now expected to be the hardest hit from the coronavirus economic repercussions (outside of China), it looks very possible that the country’s economy could tip into recession in the first quarter of this year.

Fed strikes optimistic note in January meeting minutes

Last night’s Federal Reserve minutes provided further impetus to the greenback, which posted sharp gains against the pound and modest ones versus the euro.

According to Wednesday’s FOMC minutes, the economy was proving stronger than they had expected, with indicators of recession risk no longer flashing concern. Policymakers noted their belief that the downside risks to the economy had abated, with rate-setters also voicing optimism that inflation would move towards the 2% target. The minutes noted ‘maintaining the current policy stance for a time could be helpful in supporting U.S. economic activity in the face of global developments that have been weighing on spending decisions’. This reinforces our view that the Fed will keep rates on hold throughout 2020.

EUR/USD touched a fresh three-year low this morning following the release of the Fed’s minutes. We think that much of this is, however, due to ongoing concerns regarding the recent weakness shown in European data. This afternoon’s ECB meeting accounts may shed some more light on this, although we expect Friday’s more timely PMI data to be of greater importance to currency traders.

Ongoing Brexit wrangling weighs on sterling

Sterling fell sharply on Wednesday, shedding over half a percent of its value versus the dollar to trade this morning back around the 1.29 mark.

The rationale for the above move can be attributed to both pound weakness and dollar strength. The former has benefitted from pressure on both the yen and the euro in the past few days, while the UK currency has been dragged lower by the ongoing political wrangling between the UK and the European Union. In an exchange on Twitter yesterday, the Prime Minister’s official media team questioned the European Commission’s stance towards the future trade relationship between the bloc and the UK, a stance that they believe has changed since 2017.

The ongoing political uncertainty was more than enough to offset Wednesday’s impressive UK inflation data (Figure 1), which has now pushed the date at which the market is pricing in a BoE rate cut to November. We think that the chance for an insurance rate cut has now passed, given our view for an improvement in UK data in the coming months.

Figure 1: UK Inflation Rate (2013 – 2020)